Fallen MBS Prompts CUNA Mutual Suit

CUNA Mutual Insurance Society, CUMIS Insurance Society and MEMBERS Life Insurance Co., have filed suit against RBS Securities Inc. claiming that the firm made false representations of its offering documents at the time that more than a dozen residential mortgage-backed securities were purchased by the three plaintiffs.

According to the CUNA Mutual complaint, between 2004 and 2007, the company said RBS “induced” it to buy 15 certificates in 10 separate RMBS offerings by making representations about the credit quality of the pools of mortgage loans collateralizing those RMBS.

RBS made these representations through its offering documents, which consisted of registration statements, prospectuses, term sheets, free writing prospectuses and prospectus supplements, CUNA Mutual said. The documents supposedly contained various statistical representations about the loan pools backing the RMBS, including their loan-to-value ratios, combined loan-to-value ratios and owner occupancy rates.

“For investors like CUNA Mutual, these quantitative representations were material because they provided an indication of anticipated default rates in the loan pools and anticipated foreclosure recoveries on the defaulted loans,” the complaint read.

CUNA Mutual said it relied on RBS’s quantitative representations in deciding to purchase 15 certificates in the10 separate RMBS offerings. After CUNA Mutual’s purchases, all 10 of the securities performed poorly, and the 15 certificates have since lost much of their value, according to the complaint.

CUNA Mutual said it is seeking to recover $72 million, the amount it would take for RBS to buy back the failed RMBS.

“This action is about righting a wrong and is being taken in the best interests of CUNA Mutual Group and its policyholders” said Jim Buchheim, CUNA Mutual vice president of corporate communications, in a statement. “The complaint we filed fully explains why we took this action. However, because this issue is in litigation, we will not comment further on the lawsuit.”

Before it filed the lawsuit, CUNA Mutual said it commissioned a forensic investigation of the loan pools collateralizing the 10 RMBS to test the accuracy of RBS’s quantitative representations. It sampled 17,949 loans from each transaction and conducted a retroactive appraisal using valuation models and historical data to test RBS’s representations about LTV and CLTV ratios. CUNA Mutual also analyzed public records to test RBS’s representations about owner occupancy rates.

CUNA Mutual said its investigation revealed that RBS’s quantitative representations in the offering documents of the 10 RMBS were false at the time they were made. Specifically, RBS “dramatically understated the LTV or CLTV ratios of the loan pools underlying the 10 RMBS.”

On average, the actual weighted average LTV or CLTV ratio across the10 RMBS was 11.8% higher than what RBS represented, according to the complaint.

CUNA Mutual said RBS also falsely represented that loan in the pools had an LTV or CLTV ratio above 100%. On average, 26.9% of the sampled mortgage loans had LTV or CLTV ratios above 100%, meaning the outstanding loans on the mortgaged properties exceeded the value of the properties at the time of loan origination.

According to the complaint, RBS also “dramatically overstated” the percentage of the mortgages in the underlying loan pools that were owner occupied. On average, each of the 10 RMBS overstated owner occupancy rates by 12.1%, the complaint said.

“These actual statistical characteristics made the mortgage pools underlying the 10 RMBS at issue much more risky than RBS’s statistical representations indicated,” CUNA Mutual said in its complaint.

RBS also allegedly made representations about the mortgage underwriting standards of the originators that issued the mortgage loans that served as the collateral for the 10 RMBS, according to CUNA Mutual. Specifically, RBS represented that the originators adhered to the underwriting standards set out in the offering documents.

“These representations were material to CUNA Mutual because they provided another indication of the credit risk associated with the loan pools in the RMBS. CUNA Mutual relied on these representations about adherence to underwriting standards when deciding to purchase certificates in all 10 RMBS at issue,” the company said.

RBS’s representations about the originators’ adherence to underwriting standards were also false at the time they were made, according to CUNA Mutual.

“In truth, the originators had systematically abandoned their underwriting standards. The originators’ abandonment of underwriting standards has been revealed through regulatory, judicial and media scrutiny following the collapse of the RMBS market in the second half of 2007,” the complaint said.

Because the mortgages in the pools collateralizing the RMBS were largely underwritten without adherence to underwriting standards, they were significantly riskier than RBS represented, CUNA Mutual said. A material percentage of the borrowers whose mortgages comprised the RMBS purchased by CUNA Mutual “were all but certain to become delinquent or default after origination. As a result, the RMBS were destined from inception to perform poorly.”

CUNA Mutual also charged that RBS used inflated credit ratings to “induce” the company to buy the 15 certificates.

“Institutional investors like CUNA Mutual predominantly invest in relatively low-risk, investment grade RMBS. RBS gave the rating agencies the same false quantitative data about loan characteristics and made the same representations about adherence to underwriting standards that it made to CUNA Mutual,” according to the complaint.

The rating agencies then projected the performance of the RMBS based on these “false assumptions” and because those assumptions understated the credit risk of the collateral pools, the rating agencies assigned inflated credit ratings to the certificates in the 10 RMBS. RBS then used the inflated ratings to market the certificates to CUNA Mutual while representing that the inflated ratings were an accurate measure of the certificates’ credit quality, the company said.

CUNA Mutual said it “does not allege–and its complaint should not be read to imply–that RBS intentionally or knowingly misrepresented quantitative loan characteristics, favorable ratings and adherence to underwriting standards when it sold the 15 certificates at issue to CUNA Mutual. But these misrepresentations, even if negligently or innocently made, entitle CUNA Mutual to rescind its purchase of the 15 certificates.”